When a company pays a dividend, those who hold long and/or short positions in the company's stock (e.g., firms, funds, individuals, etc.) accrue rights and obligations corresponding to their position. For example, a long position holder who is the shareholder of a stock is entitled to a real dividend. The real dividend is paid by the company to the shareholder (e.g., directly or indirectly). The shareholder receives an amount equal to the announced dividend, minus any withholding tax paid to the relevant taxing authority. The situation is handled somewhat differently when the long position holder has loaned their stock to a third party. In this case, the real dividend may be paid to the third party, or even to someone else, for example, if the third party has sold the borrowed stock. In this case, the third party is obligated to make the long position holder whole by generating and paying a manufactured dividend. Various tax rules must also be taken into consideration.
For large financial firms and other similar institutions keeping track of real and manufactured dividends may present a considerable problem. For example, firms often hold multiple positions in their own right and for clients. If any of the firm's positions overlap, or offset each other, then the firm may not receive enough real dividends to pay the long position holders. Deficiencies are made up by manufactured dividends from the short position holders. When a dividend is announced, the firm must determine which long positions will receive real dividends, which will receive manufactured dividends, and correctly apply the applicable tax and other regulations.